No. 14




Business Environment and Labour Relations *

18 December 2006


RiTo No. 14, 2006

Despite impressive economic growth rates (since 1994, GDP has doubled in real terms), and like many other transition economies, for many years Estonia has experienced jobless or even job loss growth. Employment declined between 1994 and 2005 from 675,000 to 602,000. This job loss partly reflects closure of many enterprises, as well as “defensive restructuring” by enterprises, a process in which redundant labour is shed in order to increase productivity, the gains from which are then translated into higher wages rather than higher employment.

A favourable business environment is essential for promoting creation of new businesses, growth of established firms, and job creation. This report analyses various business constraints that hinder business establishment and employment growth using the findings of the EBRD/World Bank Business Environment and Enterprise Performance Surveys (BEEPS) and World Bank Doing Business 2007 surveys of firms in Estonia.

Entrepreneurs still face serious challenges to launching a business in Estonia. They can expect to go through six steps to launch a business over 35 days, on average, at a cost equal to 5.1 percent of gross national income (GNI) per capita, and must deposit at least 34.0 percent of GNI per capita in a bank to obtain a business registration number. This is at the level or below the level in other transition countries, but the procedures are much more complex compared to high-income countries One of the priorities of the national economic policy should be to eliminate what are mostly bureaucratic financial and organizational barriers to development of entrepreneurship.

In the last three years the ratio of employers indicating labour regulations as a constraint to job creation has increased from 20% to more than 50%, and rigid labour regulations have become the leading constraint to business expansion. This points to the necessity of adjusting labour relations in particular to reflect the changes in the overall economic situation. Employers in Estonia are now more satisfied with skills of their workers but one quarter of firms in the 2005 BEEPS identified lack of skills or education as a constraint to business expansion.

Despite recent tax reforms in Estonia, according to Doing Business 2007 data a medium-size company must pay 50.2 per cent of its gross profit in taxes (including corporate income tax, social contributions and VAT) compared to 56.0 per cent in the ECA region but 47.8 percent in high-income OECD countries.  Tax system is heavily biased towards taxation of labour which is taxed at a rate of 40 percent on average (tax wedge) compared to 12% on capital. Low paid wage earners in Estonia are also relatively highly taxed compared to the tax wedge of wage earners at 50% average wage levels in EU-15. Less progressive tax wedge has an impact of employment of low qualified workers but also youth and other vulnerable groups.

*The views expressed in this article reflect the personal opinions of the author, and may not coincide with the official positions of the World Bank.

Full article in Estonian